Sometimes it seems like stock market investing is a sucker's game. Why entrust your hard-earned money to captains of industry that can't even run their companies successfully or without resorting to short-term manipulations?
But while there will always be bad apples or crooks out there in the business world, the stock market still offers the easiest and most direct route to accumulating wealth over the long-run. And new research shows that the smartest individuals in our nation tend to agree with that assessment.
Working smarter, nor harder
A forthcoming piece of research from the Journal of Finance looks at how IQ is related to stock market participation. The results of the study show that, controlling for other factors such as wealth, income, age, and occupation, participation in the stock market rises as IQ level goes up. The data also showed that higher IQ investors are more likely to hold mutual funds and a larger number of stocks, experience lower risk, and earn greater returns for any given level of risk.
But even if you don't qualify for membership in Mensa, that doesn't mean that you're doomed to make bad investment choices for the rest of your life. Rather, it may be a good idea to examine how the smartest investors approach stock market investing and perhaps make a few adjustments to your own approach based on these concepts. After all, investing really isn't rocket science -- if you keep a few simple things in mind.
Multiple eggs, multiple baskets
One of the key findings of this latest research is that high-IQ investors know the value of diversification. Since these folks are more likely to own mutual funds and greater numbers of individual stocks than other investors, they clearly place a premium on owning a diversified portfolio. So rather than using their superior intellect to identify and load up on two or three or even 10 underpriced stocks, high-IQ investors tend to spread their bets across sectors and regions and own dozens or hundreds of names through mutual fund investments.
That means you're probably not going to get rich going all-in on gold and silver investments or cloud computing stocks. Rather, taking a broad-market approach is likely to yield better results. One of the easiest ways to duplicate this high-IQ investing approach is to use low-cost exchange-traded funds. But the key here is to stick to well-diversified funds rather than sector- or country-specific funds. So ETFs like Vanguard Total Stock Market ETF (NYSE: VTI ) for domestic stock market coverage or Vanguard Emerging Markets Stock ETF (NYSE: VWO ) for exposure to foreign developing countries should be at the top of your list.
The tortoise or the hare?
The finding that the highest IQ investors are more likely to hold mutual funds may seem somewhat counterintuitive. After all, don't most mutual funds underperform the market? If these people are so smart, why can't they just make a few stock picks and ride those picks to prosperity?
Well, maybe what the high-IQ folks have figured out is that taking a disciplined, well-diversified, and somewhat boring approach actually provides greater long-term returns than a fast paced, market timing strategy that chases the return of a few hot-performing stocks or sectors. It's true that you won't crush the market with the majority of mutual funds, but sticking to your long-run plan regardless of what the market is doing in the short-run is likely to yield better results than a shoot-for-the-moon, get-rich-quick approach.
Of course, this doesn't mean that you have to give up on stock-picking if you want to emulate the high-IQ investing approach. There is always room for carefully selected names in anyone's portfolio. But you need to first have a solid, diversified base of investments before you delve into serious stock-picking efforts. You can accomplish this through owning ETFs, or if you still want the opportunity to beat the market, by identifying the rare few actively managed mutual funds that do outperform over time.
One good example here is Dodge & Cox Stock (DODGX). This fund utilizes a time-tested team-based approach to selecting stocks. Near-term performance doesn't look great, thanks to the shop's stumbles during the financial crisis and lagging performance in 2007 and 2008. But don't be fooled -- this fund is a long-term winner. Even with recent performance working against it, the fund still ranks ahead of 97% of all large-cap value funds in the past 15 years.
Right now the team is finding a lot of value in reasonably priced health care and information technology names. Management likes pharmaceutical names like Amgen (Nasdaq: AMGN ) and Roche Holdings because of their historically low valuations and proprietary products that are more resistant to generic drug competitors. These names sit alongside other reasonably priced health care names in the portfolio such as Novartis (NYSE: NVS ) and Pfizer (NYSE: PFE ) .
Ultimately, you don't need a genius IQ to succeed at the investing game. However, it's probably not a bad idea to take note of what the smarty-pants are doing and incorporate some of those moves into your own investing regimen. That means making sure that low-cost, diversified mutual funds play a big role in your long-term plans.
For more winning mutual fund recommendations and time-tested personal financial planning advice, check out the Fool's Rule Your Retirement service. You can start your free 30-day trial today.
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